China Alert: Foreign Control: Caution – difficult (and expensive) decisions ahead
• Majority foreign-control in China is now on the table. But let’s just slow down for a moment.
• There are a number of key strategic decisions that will need to be made. Five are included here.
• How global managers approach this process will define the competitive landscape over the next decade.
There remains an enormous amount of uncertainty regarding majority ownership and global managers should pause to consider what this actually means. We’ve identified five initial key questions that need to be addressed right now, especially by those with a joint venture FMC.
What is the value of majority ownership?
After a decade of M&A work, Z-Ben Advisors typically prices the enterprise value of a fund manager in a PE range of 15x to 17x historical earnings – that is just a starting point. A premium for control will need to be added and with it the price point should be expected to rise exponentially. At the same time, moving to full control (100%) will need to be negotiated. This has been attempted in the past through option agreements (the move from 33% to 49%) with mixed – and again expensive – results. We are speaking to what could very well be an expensive market entry option.
Is it better to “buy” or “build”?
There are now two separate routes to access China’s large and growing retail mutual fund market: buying a controlling stake in a pre-existing fund manager or going down the path of the WFOE. There are pros and cons to both approaches and it all may boil down to a simple binary decision: acquiring majority control of a fund manager today will be more expensive, but offers up an in-place business platform with product and revenue. Then there is the WFOE approach, which would be far more economical but requires a great deal more time and effort before success and scale is attained. Which is best will depend on the global manager assessing the two options.
Where will the regulations land?
There are currently managers with both a JV and a WFOE. At present, there is no need to choose between the two and there are no written regulations that say a foreign manager cannot hold one majority and one minority stake in FMCs. Optionality! It is one of the two keys to an increased probability for success. Be mindful though, waiting for greater clarity in the rules and regulations could very well see the competitive landscape shift under your feet. Those first through the door might get bloodied. They also might gain the upper hand. In addition, based on client engagement over the past two years, existing regulations can allow for greater maneuverability. But just so you know, to the regulators, those well-established in China tend to get seen first. Legal opinions, while deployed in multitudes and of varying quality, will be of little assistance at this point in time.
Do you need a domestic partner to succeed commercially?
Every global asset manager with a JV in China claims to have a great relationship with their domestic partner. Well, that thesis is about to be tested like never before. Taking control and pressing for full ownership in a few years’ time will fundamentally alter the current relationship. For some this may be a moot point, for others it may not. What is certain is the need to fully assess what a Chinese partner brings to the table and whether that value is central to the fund platform’s historic, and future, success.
Conversely, does your domestic partner see you as value-adding?
We are not speaking to a one-way street here. Foreign shareholders in a JV are more often than not rewarded annually with some very rich dividend streams. So rich in fact that more than a few domestic partners will be questioning if retaining a foreign shareholder even makes financial sense. Why shouldn’t the Chinese partner just take full control themselves? Now we know that most foreign managers with a JV may be considering how to go about taking control. These very same groups will need to be mindful that they could just as well find themselves with a counter offer by the Chinese party. With that, we come full circle: the price point a Chinese partner is willing to sell at isn’t anywhere near the price point it would be willing to buy at.
These are just the five most pertinent questions that come to Z-Ben Advisors’ mind in the matter of a few hours. Give us the weekend and rest assured there will be more come Monday morning. Think it all through and consider the impact on your business. It’s integral that you can answer these questions: the economic and competitive implications will be significant.
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Trey Archer – Tel: (+86 21) 6075-8163 Email: [email protected]